Asia's markets start to crack under dollar pressure amid Mideast war

Asia's financial markets are almost at breaking point.

Currencies are crumbling, forcing central banks to lend them support. Stocks are sliding, credit risk is rising and borrowing costs are spiralling higher across the region.

It's the twin catalysts of ever-increasing US interest rates and rising tension in the Middle East that are inflicting pain all around. A widening yield premium for US Treasuries sucks capital from the rest of the world into the US, while the risk of escalation in the Israel-Hamas war saps demand for assets perceived to be higher risk.

Asia stocks had fallen to an 11-month low overnight on Friday. The fallout is widespread this month. Red October rumbled on in world markets on Friday as the sight of US government bonds yields hitting 5% for the first time since 2007 amid an increasingly threatening conflict in the Middle East left investors searching for safety. 

Wall Street has lost 2% over the last two days and Europe's share markets dropped 1% on Friday.

And it's proving almost too much for Asia's markets to take.

Malaysia's ringgit slid beyond its 2022 nadir Thursday, taking it to the weakest level since the Asia Financial Crisis in 1998. Measures of implied volatility whipped up for Japan's yen as it traded within a whisker of 150 per dollar, stoking concern authorities would intervene to support the currency. India's rupee matched its record low and the Bloomberg Asia Dollar Index sank to its weakest level since November.

Several of the region's central banks including the Philippines are actively intervening in foreign-exchange markets to prevent currency weakness, fearing the resulting increase in import costs would stoke inflation. Indonesia's central bank took the surprise step of raising borrowing costs Thursday in what Governor Perry Warjiyo called "a pre-emptive and forward looking step" to boost the rupiah.

Separate data showed Chinese investors offloaded the most US bonds and stocks in four years in August, fuelling speculation that authorities were beefing up their war chest to defend a weakening yuan. China's bonds yield the least relative to US Treasuries since 2002, weighing on the nation's currency.

The violence in Israel is adding to the region's stresses. Bank of Korea Governor Rhee Chang-yong warned Thursday of the risk of market jitters stemming from the conflict. Stocks slid across the region, with mainland Chinese gauges nearing their 2022 low point.

"There is portfolio de-risking, probably raising cash in anticipation of escalating geopolitical risks in the Middle East from Israel's potential ground invasion of the Gaza strip and potential violent retaliation against Israel," said Alan Richardson, senior portfolio manager at Samsung Asset Management.

Bonds are also under pressure in Asia as investors demand higher yields to compete with those available in US markets. That drives up funding costs for governments and companies in the region. Several Japanese sales of corporate bonds have been postponed or cancelled recently as a result of the market conditions.

And spreads on investment-grade Asia ex-Japan dollar bonds climbed at least 2 basis points Thursday, on course for the most widening in about two weeks.

It's all set to keep Asia's central bankers and the region's investors on edge.

"The global dynamic is very fast," said Bank Indonesia's Warjiyo. "We need to review again from month to month. Our goal is the same: price stability, financial system stability and payment system stability to support our economic growth."

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.